diff --git a/proposals/0228-market-based-emission-mechanism.md b/proposals/0228-market-based-emission-mechanism.md new file mode 100644 index 000000000..b3390f56f --- /dev/null +++ b/proposals/0228-market-based-emission-mechanism.md @@ -0,0 +1,188 @@ +--- +simd: '0228' +title: Market-Based Emission Mechanism +authors: + - Tushar Jain + - Vishal Kankani + - Max Resnick +category: Standard +type: Core +status: Review +created: 2025-01-16 +--- + + +## Summary + +SIMD-0228 Introduces a Market-Based emission mechanism based on staking +participation rates. The mechanism is a static curve that reduces the total issuance +rate by a factor of the square root of the staking participation rate. + +## Motivation + +Solana has historically relied on token emissions to attract stake and guarantee +security. As Solana matures, stakers are increasingly earning SOL from other +sources (e.g. MEV). These developments have resulted in an increasing fraction +of the Solana supply staked, meaning the network is now overpaying security +since emissions haven't adjusted to the elevated demand for staking. + +According to Blockworks (), in Q4 2024 +MEV, as measured by Jito Tips, was approximately \$430M (2.1M SOL), representing +massive quarter-over-quarter growth. In Q3 Jito Tips were approximately +\$86M (562k SOL), Q2 was approximately \$117M (747k SOL), and Q1 was approximately +\$42M (300k SOL). + +Given the level of economic activity the network has achieved and the subsequent +revenue earned by stakers from MEV, now is a good time to revisit the network's +emission mechanism and evolve it from a fixed-schedule mechanism to a +programmatic, market-driven mechanism. + +The purpose of token emissions in Proof of Stake (PoS) networks is to attract +stakers and validators to secure the network. But excessive issuance is costly +because it imposes frictions on the network and crowds out SOL usage in DeFi. +Therefore, the most efficient amount of token issuance is the lowest rate +necessary to secure the network. + +Solana's current emission mechanism is a fixed, time-based, formula that was +activated on epoch 150, a year after genesis on February 10, 2021. The mechanism +is not aware of network activity, nor does it incorporate that to determine the +emission rate. Simply put, it's "dumb emissions." Given Solana's thriving +economic activity, it makes sense to evolve the network's monetary policy with +"smart emissions." + +There are two major implications of Smart Emissions: + +Smart Emissions dynamically incentivizes participation when stake drops to +secure the network. +Smart Emissions minimize SOL issuance to the Minimum Necessary Amount (MNA) to +secure the network. + +This is good for the Solana network and network stakers for four reasons: + +High inflation can lead to more centralized ownership. To illustrate the point, +imagine a network with an exceedingly high inflation rate of 10,000%. People who +do not stake are diluted and lose ~99% of their network ownership every year to +stakers. The higher the inflation rate, the more network ownership is +concentrated in stakers' hands after compounding for years. + +Reducing inflation spurs SOL usage in DeFi, which is ultimately good for the +applications and stimulates new protocol development. Additionally, a high +staking rate can be viewed as unhealthy for new DeFi protocols, since it means +the implied hurdle rate is the inflation cost. Lowering the "risk free" +inflation rate creates stimulative conditions and allows new protocols to grow. + +If Smart Emissions function as designed, they will systematically reduce selling +pressure as long as staking participation remains adequate. The inevitable side +effect and primary downside to high token inflation is increased selling +pressure. This is because some stakers in different jurisdictions have taken the +interpretation that staking creates ordinary income, and therefore they must +sell a portion of their staking rewards to pay taxes. This selling is a +significant detriment to the network and does not benefit the network in any +way. + +In markets, sometimes perception is as important as reality. While SOL inflation +is technically not cost to the network, others think it is, and that belief +overall has a negative impact on the network. Inflation causes long-term, +continual downward price pressure that negatively distorts the market's price +signal and hinders fair price comparison. To use an analogy from traditional +financial markets, PoS inflation is equivalent to a publicly listed company +doing a small share split every two days. + +Historically, issuance curves have remained static due to Bitcoin's immutability +ethos—a "Bitcoin Hangover" so to speak. While immutability suits Bitcoin's +mission to become digital gold, it doesn't map to Solana's mission to +synchronize the world's state at light speed. + +In summary, the current Solana emissions schedule is suboptimal given the +current level of activity and fees on the network because it emits more SOL than +is necessary to secure the network. An issuance curve set by diktat is not the +right long-term approach for Solana. Markets are the best mechanism in the world +to determine prices, and therefore, they should be used to determine Solana's +emissions. + + +## New Terminology + +- Fraction of total supply staked: $s$ +- Issuance Rate $i$ +- Validator returns $v(s) = \frac{i}{s} + MEV$ +- r is the current inflation rate which is a constant (currently 4.5%) that +automatically goes down by 15% every year until it reaches 1.5% where it +stops changing. + +## Detailed Design + +### New Emission Rate Formula + +The issuance rate formula is: + +$$i(s) = r(1 - \sqrt{s})$$ + +![Issuance Rate](../suporting_images/0228-market-based-emission-mechanism/issuance_rate.png) + +This yields a vote reward rate for validators with good performance of: + +$$v(s) = \frac{i(s)}{s} = \frac{r(1 - \sqrt{s})}{s}$$ + +![Issuance Rate](../suporting_images/0228-market-based-emission-mechanism/validator_returns.png) + +## Alternatives Considered + +### Alternative Design 1: Pick another fixed rate + +A simple alternative would be to adjust the issuance rate to a fixed number, $r$ +determined by community inputs. However, this approach presents several risks: +Lack of Market Mechanisms: Setting a fixed rate ignores the dynamics of free +markets and the network's real-time economic conditions: + +- **Lack of Market Mechanisms**: Setting a fixed rate ignores the dynamics of + free markets and the network's real-time economic conditions +- **Arbitrary Adjustments**: Using another arbitrary number risks undermining the + integrity of the system and may lead to decisions that are disconnected from the +network's needs +- **Erosion of Trust**: Relying on fixed adjustments could erode trust in the +community's decision-making process, especially if future changes seem +disconnected from market realities +- **Compromised Consensus Safety**: A fixed issuance rate, especially in + uncharted territory, could undermine consensus safety, as it would not be +dynamically tied to staking participation or broader network health + +### Alternative Design 2: Fix Target Staking Yield + +- **Revenue Source**: MEV has become a significant revenue source for stakers. +- **Proposed Change**: One can consider changing the issuance rate by factoring +in MEV tips, maintaining the same target yield as the original curve but +offsetting it by the 30-day moving average of MEV tips. +- **Formula**: New Issuance Rate (i) = Target Staking Yield − 30-day moving + average of MEV tips +- **Market Impact**: MEV tips reflect real revenue for validators and stakers, +allowing the system to adjust to market conditions: + - **Hot Markets**: Higher MEV tips allow for lower emissions. + - **Cold Markets**: Increased emissions compensate validators, maintaining + network security. +- **Inspiration**: This approach is inspired by central bank monetary policy, +adjusting inflation based on economic conditions. +- **Key Challenge**: The big challenge with this design is that it incentivizes +MEV payments to move out of sight of the tracking mechanism, thereby rendering +the design completely ineffective. +- **Important Note**: For an abundance of clarity, we are not proposing any design +which requires measuring MEV payments. + +## Impact + +Implemented thoughtfully, this design could have a major positive economic +impact on the overall health of the Solana economy. + +## Security Considerations + +The biggest concern for this proposal is that it could reduce the amount of SOL +staked more than desired. We can assure ourselves that at least with current +market conditions the resulting equilibrium staked amount would be more than 30% +with the following reasoning: + +Currently the issuance rate is 4.5% and the staked amount is 65% which comes out +to around 6.25% validator rewards for performant stakers (not including MEV). +If the issuance rate were instead governed by this proposal, we should expect +the staked amount to be more than 30% because $v(30\%) \approx 6.25\%$. +We know that $D(6.25\%)$ = 65% and therefore the staked amount under the new +issuance rate would be more than 30% if demand stays the same. diff --git a/suporting_images/0228-market-based-emission-mechanism/issuance_rate.png b/suporting_images/0228-market-based-emission-mechanism/issuance_rate.png new file mode 100644 index 000000000..b19232de2 Binary files /dev/null and b/suporting_images/0228-market-based-emission-mechanism/issuance_rate.png differ diff --git a/suporting_images/0228-market-based-emission-mechanism/validator_returns.png b/suporting_images/0228-market-based-emission-mechanism/validator_returns.png new file mode 100644 index 000000000..21daebac7 Binary files /dev/null and b/suporting_images/0228-market-based-emission-mechanism/validator_returns.png differ